How and Why We Discard 99% of Companies

OIJ (#41) Stop trying to make the math work. Start demanding a 15% yield.

Valuation often feels like a black box of complex spreadsheets and endless assumptions. But true investment clarity comes from simplicity.

At The Hermit, we don’t guess; we demand proof of value.

Our strategy strips away the noise and focuses on three non-negotiable pillars. Here is how we identify the winners and, more importantly, discard the rest.

15% FCF Yield

Cash is reality. While accounting tricks can massage earnings, Free Cash Flow (FCF) is the cold, hard cash a business generates after paying for everything it needs to survive and grow.

We have a strict hurdle: A minimum 15% FCF Yield.

Think of it this way: If we bought the entire company today, we would expect it to return 15% of our purchase price in cash within year one.

It is effectively a 15% dividend yield (before taxes).

This high hurdle provides a massive Margin of Safety. It ensures we are buying high-quality assets at a discount, protecting our downside while positioning us for exceptional upside.

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Understanding EBIT and FCF Multiples

Multiples act as a thermometer, telling you if a stock is “hot” or “cold.” But temperature isn’t substance. Multiples often fluctuate based on wild expectations, not reality. We mostly ignore earnings, price and book value multiples, and ground our analysis in the only metric that doesn’t lie: Cash Flow.

• EBIT Multiple (EV/EBIT). This measures the profitability of operations.

  • It helps us compare the raw pricing power and efficiency.

  • We also use Enterprise Value (EV) instead of Market Cap because we want to account for the company's net debt. Very important.

• FCF Multiple (P/FCF). This is the inverse of our yield. A 15% yield roughly equals a 6.6x FCF multiple.

  • Market Standard: Most investors are happy paying 15x or 20x for a business.

  • Our Take: We want to pay less than 7x.

By insisting on lower multiples, we purchase the same dollar of profit for a fraction of the market price. This discipline comes with a trade-off: our strict price targets mean we miss out on many popular opportunities.

And we will take it… every time.

This approach prevents catastrophic mistakes by ensuring we enter a position only when the valuation provides an undeniable safety net.

We want to be the buyer of last resort.

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The Power of “No!”

Successful investing isn’t just about what you buy; it’s about what you ignore.

We view the market as a funnel. To find the “good stuff”, you must ruthlessly sift through the dirt. We practice the art of fast discarding.

Does the company have high debt? Discard.

Is the management team questionable? Discard.

Are compensation incentives perverse? Discard.

Is the FCF yield under 15%? Discard.

We don’t waste time trying to “make the math work” for a mediocre company. If a stock doesn’t scream “undervalued” within minutes based on our strict metrics, we move on.

This discipline acts as a firewall against emotional errors, ensuring we only hold our best ideas.

However, discarding a company doesn’t mean deleting it from existence. It simply moves to our watchlist.

Note: the average stock fluctuates wildly, with its 52-week high often sitting 50% higher than its low in a single year.

We revisit these names periodically because market sentiment shifts quickly.

Who knows? That quality company you’ve always liked might finally trade at a discount tomorrow.

We’re giving you The Hermit Valuation Framework

If you want to dig deeper, click the link below to read the full story and download our prop valuation tool. It’s entirely free.

The Hermit Valuation Framework

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